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Human Resource Management

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Human Resource Management (MGT501)
VU
Lesson 28
COMPENSATION SYSTEM
After studying this chapter, students should be able to understand the following:
A. Job Pricing & Developing a Base Pay System
B. Compensation system
LESSON OVERVIEW
We begin this chapter with an overview of compensation and an explanation of compensation equity. Next,
we discuss determinants of individual financial compensation and the organization as a determinant of
financial compensation. This is followed by a discussion of the labor market, the job, and the employee, as
determinants of financial compensation. Finally, job pricing and executive compensation are presented.
To understand the basic concepts of compensation first of all we will define the pay
Pay:
Pay is a statement of an employee's worth by an employer.
Or
Pay is a perception of worth by an employee
HR Management Strategy Model:
Human resource department uses different
strategies to mange the workforce so that the
HR Management Strategy Model
desired results can be attained. These desired
result as stated in earlier chapters as well, can be
attained if organization is able to attract, select,
develop and retain workforce in successful
Attract
Select
manner in short, the effective hiring and
retaining workforce can be helpful in achieving
HR
organizational goals. This purpose can be
Desired
Rewards
Strategy
attained through fair and effective rewards
Results
systems in the organization. Rewards are used as
Retain
Engage
basic motivational tools in the organization so
that performance of the employees can be
Develop
influenced in desirable way. So to be more
successful organizations need attractive and fair
compensation and reward systems to be paid to
the workforce.
A. Job Pricing
Job pricing means placing a dollar value on the worth of a job.
I. Pay Grades--The grouping of similar jobs together to simplify the job pricing process. Plotting
jobs on a scatter diagram is often useful in determining the appropriate number of pay grades.
II. Wage Curve--The fitting of plotted points in order to create a smooth progression between pay
grades.
III. Pay Ranges--Includes a minimum and maximum pay rate with enough variance between the
two to allow some significant pay difference.
IV. Broad Banding--A technique that collapses many pay grades (salary grades) into a few wide
bands in order to improve organizational effectiveness.
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V. Single-Rate System--Pay ranges are not appropriate for some workplace conditions. When
single rates are used, everyone in the same job receives the same base pay, regardless of seniority
or productivity. This rate may correspond to the midpoint of a range determined by a
compensation survey.
VI. Adjusting Pay Rates--when pay ranges have been determined and jobs assigned to pay grades,
it may become obvious that some jobs are overpaid and others underpaid. Underpaid jobs
normally are brought to the minimum of the pay range as soon as possible.
B. Compensation: An Overview
i. Compensation--The total of all rewards provided employees in return for their services.
ii. Direct Financial Compensation--Consists of the pay that a person receives in the form of
wages, salaries, bonuses, and commissions.
iii. Indirect Financial Compensation--All financial rewards that are not included in direct
compensation.
iv. Non-financial Compensation--Consists of the satisfaction that a person receives from the job
itself or from the psychological and/or physical environment in which the person works. All such
rewards comprise a total compensation program.
I. Equity in financial compensation :
Organizations must attract, motivate, and retain competent employees. Because achievement of these goals
is largely accomplished through a firm's compensation system, organizations must strive for compensation
equity.
a.
Equity--Workers' perceptions that they are being treated fairly. Compensation must be
fair to all parties concerned and be perceived as fair.
b. External Equity--Exists when a firm's employees are paid comparably to workers who
perform similar jobs in other firms.
c.
Internal Equity--Exists when employees are paid according to the relative value of their
jobs within an organization.
d. Employee Equity--Exists when individuals performing similar jobs for the same firm are
paid according to factors unique to the employee, such as performance level or seniority.
e.
Team Equity--Achieved when more productive teams are rewarded more than less-
productive teams.
II. Determinants of individual financial compensation:
Compensation theory has never been able to provide a completely satisfactory answer to what an individual
is worth for performing jobs.
 The Organization,
 The Labor Market,
 The Job, and
 The Employee
These all have an impact on job pricing and the ultimate determination of an individual's financial
compensation.
a.
The Organization as a Determinant of Financial Compensation:
Compensation Policies--An organization often establishes--formally or informally--
compensation policies that determine whether it will be a pay leader, a pay follower, or
strive for an average position in the labor market.
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1. Pay Leaders: Those organizations that pay higher wages and salaries than competing firms.
2. Market Rate or Going Rate: The average pay that most employers provide for the same job in a
particular area or industry.
3. Pay Followers: Companies that choose to pay below the market rate because of poor financial
condition or a belief that they simply do not require highly capable employees.
Organizational Politics--Political considerations may also enter into the equation. A
sound, objective compensation system can be destroyed by organizational politics.
Managers should become aware of this possibility and take appropriate action.
Ability to Pay--An organization's assessment of its ability to pay is also an important
factor in determining pay levels. Financially successful firms tend to provide higher-than-
average compensation. However, an organization's financial strength establishes only the
upper limit of what it will pay.
b. The labor market as a determinant of financial compensation:
Potential employees located within the geographical area from which employees are recruited comprise the
labor market.
Compensation Surveys--Large organizations routinely conduct compensation surveys to
determine prevailing pay rates within labor markets.
1. Compensation surveys: Provide information for establishing both direct and indirect compensation.
2. Benchmark job: A job that is well known in the company and industry, one that represents the
entire job structure, and one in which a large percentage of the workforce is employed.
Cost of Living--A pay increase must be roughly the equivalent to the cost of living
increase if a person is to maintain a previous level of real wages.
Labor Unions--When a union uses comparable pay as a standard for making
compensation demands, the employer must obtain accurate labor market data. When a
union emphasizes cost of living, management may be pressured to include a cost-of-living
allowance (COLA). This is an escalator clause in the labor agreement that automatically
increases wages as the U.S Bureau of Labor Statistics' cost-of-living index rises.
Society--Compensation paid to employees often affects a firm's pricing of its goods
and/or services. Consumers may also be interested in compensation decisions.
Economy--In most cases, the cost of living will rise in an expanding economy. Thus, the
economy's health exerts a major impact on pay decisions.
Legislation--The amount of compensation a person receives can also be affected by
certain federal and state legislation.
c.  The job as a determinant of financial compensation:
Organizations pay for the value they attach to certain duties, responsibilities, and other job-related factors.
Techniques used to determine a job's relative worth include job analysis, job descriptions, and job
evaluation.
Job Analysis and Job Descriptions--Before an organization can determine the relative difficulty or
value of its jobs, it must first define their content, which it normally does by analyzing jobs. Job analysis
is the systematic process of determining the skills and knowledge required for performing jobs. The job
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description is the primary by-product of job analysis, consisting of a written document that describes
job duties and responsibilities. Job descriptions are used for many different purposes, including job
evaluation.
Job Evaluation--That part of a compensation system in which a firm determines the relative value of
one job compared with that of another.
d. The employee as a determinant of financial compensation:
In addition to the organization, the labor market, and the job, factors related to the employee are also
essential in determining pay and employee equity.
I. Performance Based Pay--PA data provide the input for such approaches as merit pay, variable
pay, skill-based pay, and competency-based pay.
1. Merit Pay: A pay increase given to employees based on their level of performance as indicated in
the appraisal.
2. Bonus: The most common type of variable pay for performance and is a one-time award that is
not added to employees' base pay.
3. Skill-based Pay: A system that compensates employees on the basis of job-related skills and
knowledge they possess, not for their job titles.
4. Competency-Based Pay: A compensation plan that rewards employees for their demonstrated
expertise.
II. Seniority--The length of time an employee has been associated with the company, division,
department, or job is referred to as seniority.
III. Experience--Regardless of the nature of the task, very few factors has a more significant impact
on performance than experience.
IV. Membership in the Organization--Some components of individual financial compensation
are given to employees without regard to the particular job they perform or their level of
productivity.
V. Potential--Organizations do pay some individuals based on their potential.
e.
Political Influence--Political influence is a factor that obviously should not be used as a determinant
of financial compensation. However, to deny that it exists would be unrealistic.
f.
Luck--The expression has often been stated, "It certainly helps to be in the right place at the right
time." There is more than a little truth in this statement as it relates to the determination of a person's
compensation.
g. Special Employee Classes--These include pay for executives, which are discussed in a later section,
and pay for professionals and sales employees.
III. Executive Compensation:
Executive skill largely determines whether a firm will prosper, survive, or fail. Therefore, providing adequate
compensation for these managers is vital. A critical factor in attracting and retaining the best managers is a
company's program for compensating executives.
a) Determining Executive Compensation--In determining executive compensation, firms
typically prefer to relate salary growth for the highest-level managers to overall corporate
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performance. In general, the higher the managerial position, the greater the flexibility
managers have in designing their jobs.
b) Types of Executive Compensation--Executive compensation often has five basic
elements: (1) Base Salary, (2) Short-Term Incentives or Bonuses, (3) Long-Term Incentives
and Capital Appreciation Plans, (4) Executive Benefits, and (5) Perquisites. The way an
executive compensation package is designed is partially dependent on the ever-changing
tax legislation.
Base Salary: Salary is obviously important. It is a factor in determining standard
of living. Salary also provides the basis for other forms of compensation.
Short-Term Incentives or bonuses: Payment of bonuses reflects a managerial
belief in their incentive value. Today, virtually all top executives receive bonuses
that are tied to base salary.
Long-Term Incentives and Capital Appreciation: The stock option is a
long-term incentive designed to integrate further the interests of management
with those of the organization. The typical stock option plan gives the manager the
option to buy a specified amount of stock in the future at or below the current
market price.
Executive Benefits: Executive benefits are generally more generous than those
received by other employees because the benefits are tied to their higher salaries.
However, current legislation (ERISA) does restrict the value of executive
benefits to a certain level above those of other workers.
Perquisites (Perks): Any special benefits provided by a firm to a small group
of key executives that are designed to give the executives something extra. A
"golden parachute" contract is a perquisite that protects executives in the event that
their firm is acquired by another.
IV. Compensation for professionals:
People in professional jobs are initially compensated primarily for the knowledge they bring to the
organization. Because of this, the administration of compensation programs for professionals is somewhat
different than for managers. Many professional employees eventually become managers. For those who do
not desire this form of career progression, some organizations have created a dual track of compensation.
The dual track provides a separate pay structure for professionals, which may overlap a portion of the
managerial pay structure.
V. Sales Compensation:
Designing compensation programs for sales employees involves unique considerations. For example, job
content, relative job worth, and job market value should be determined. The straight salary approach is at
one extreme in sales compensation. In this method, salespersons receive a fixed salary regardless of their
sales levels. At the other extreme, the person whose pay is totally determined as a percentage of sales is on
straight commission. Between these extremes, there are endless part salary­part commission combinations.
The possibilities increase when various types of bonuses are added to the basic compensation package. In
addition to salary, commissions, and bonuses, salespersons often receive other forms of compensation that
are intended to serve as added incentives.
Role of Line managers and HRM Department in Compensation:
Line managers perform the function of job evaluation that is base for the compensation systems, according
to the worth of the job negotiation regarding the salaries and other benefits is negotiated with potential
employees through line mangers. Basic compensation packages are mostly recommended by the line
managers in the organizations. All these information is communicated to the employees by HRM
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department beside communicating this information HRM department also facilitates the departments in
establishing rates of pay, monitoring in job evaluation process, and Conducting salary surveys in order to
establish procedures for administering pay plans, and to ensure compliance with antidiscrimination laws.
Key Terms
Merit Pay: A pay increase given to employees based on their level of performance as indicated in the
appraisal.
Equity: Workers' perceptions that they are being treated fairly. Compensation must be fair to all parties
concerned and be perceived as fair
External Equity: Exists when a firm's employees are paid comparably to workers who perform similar
jobs in other firms.
Internal Equity: Exists when employees are paid according to the relative value of their jobs within an
organization.
Compensation: The total of all rewards provided employees in return for their services.
Job Pricing: Job pricing means placing a dollar value on the worth of a job.
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Table of Contents:
  1. INTRODUCTION TO HRM:Growing Importance of HRM, Road Map of the Course
  2. ESSENTIALS OF MANAGEMENT:Concepts and Essential of Management, Managerís Roles
  3. ORGANIZATION AND COMPONENTS OF ORGANIZATION:Open versus Closed Systems, The Hawthorne Studies
  4. PEOPLE AND THEIR BEHAVIOR:Why to work in organizations?, The Goals of Organizational Behavior
  5. INDIVIDUAL VS. GROUP BEHAVIOR:What Are Roles?, Problem solving Team
  6. PERSONNEL MANAGEMENT TO HUMAN RESOURCE MANAGEMENT:Records and Administration, Competitive Advantage
  7. HRM IN A CHANGING ENVIRONMENT:Productivity, New Trends at Work Place
  8. How organization Cultivate a Diverse Workforce, STEPS TOWARD MANAGEMENT OF DIVERSITY
  9. FUNCTIONS AND ENVIRONMENT OF HRM:Compensation and Benefits, Safety And Health, Interrelationships of HRM Functions
  10. LINE AND STAFF ASPECTS OF HRM:Authority, Line versus Staff Authority, Staff Manager
  11. LEGAL CONTEXT OF HR DECISIONS:Doing the Right Thing, Affirmative Action, Unintended Consequences
  12. HUMAN RESOURCE PLANNING (HRP):Benefits of HR Planning, Forecasting Human Resource Availability
  13. STRATEGIC PLANNING AND HRIS:HRís Strategic Role, Human Resource Information System, Common HRIS Functions
  14. JOB ANALYSIS:Purposes of the job Analysis, Questions Job Analysis Should Answer
  15. JOB ANALYSIS:Methods of Collecting Job Analysis Information, Observation, Source of Data
  16. JOB ANALYSIS (CONTD.):SURPLUS OF EMPLOYEES FORECASTED, Diversity through Recruiting Efforts
  17. SOURCES OF RECRUITMENT:ALTERNATIVES TO RECRUITMENT, Quantity of the Applicants, Quality of the Applicants
  18. SELECTION:Initial Screening, Advantages of Successful Screening
  19. SELECTION TESTS:Characteristics of Properly Designed Selection Tests, Guidelines for Conducting an Interview
  20. SELECTION PROCESSÖ CONTD:Background Investigations, Physical Exam, Selecting Managers
  21. SOCIALIZATION:Compensation and Benefits, Team Membership, Stages in socialization Process, Training and Development Trends
  22. TRAINING AND DEVELOPMENT:Learning, Phases of Training, Why Transfer of Training Fails
  23. MAXIMIZING LEARNING:Following up on Training, Repetition, Feedback, Purposes of T & D
  24. CAREER MANAGEMENT:Individual career planning, Career Planning and Development Methods
  25. PERFORMANCE:Determinants of Job Performance, Why is performance measured?, Performance Management
  26. PERFORMANCE APPRAISAL:What to Evaluate, The Appraisal Interview, PROBLEMS IN PERFORMANCE APPRAISAL
  27. JOB EVALUATION AND PRICING:THE APPRAISAL PERIOD, Ranking method,
  28. COMPENSATION SYSTEM:Pay, Job Pricing, Compensation: An Overview, Compensation Surveys
  29. BENEFITS:Total Compensation, Discretionary Benefits (Voluntary), Workplace Flexibility
  30. ROLE OF MONEY IN PERFORMANCE OF EMPLOYEES:Types of Pay-for-Performance Plans, Empower Employees
  31. MOTIVATION:The Motivation Process, Motivational Theories, Challenges of motivating employees
  32. OCCUPATION, HEALTH & SAFETY:Physical Conditions, Accident Investigation, Smoking in The work place
  33. STRESS MANAGEMENT:Symptoms of Stress, Managing Stress,
  34. COMMUNICATION IN ORGANIZATION:Burnout, Social Support at Work & Home, Communication in organization, Meetings
  35. TRADE UNIONS:Collective Bargaining, The HRM Department in a Nonunion Setting, Phases of Labor Relations
  36. CONFLICT AND NEGOTIATION:Transitions in Conflict Thought, Individual Conflict Management Styles
  37. POWER AND POLITICS:Sources of Power, Advantages and Disadvantages of PowerPower and Politics in Context
  38. EMPLOYEE RIGHTS AND DISCIPLINE:Contractual Rights, Management Rights, Disciplining Employees,
  39. DISCIPLINE (CONT...):Factors to Consider when Disciplining, Disciplinary Guidelines, Employee Separations
  40. LEADERSHIP:The Leaderís Behavior, Situational Theories of Leadership, Becoming a Leader
  41. REVISION (LESSON 12-21):Plans, Job Specification, Human resource planning, Selection Process, Corporate Culture
  42. REVISION (LESSON 22-26):Training, Case Study Method, Training, Performance
  43. REVISION (LESSON 27-35):Classification Method, Compensation, Empowerment, Mediation
  44. INTERNATIONAL DIMENSIONS OF HRM:Global Corporation, Type of staff members, Approaches to Global Staffing
  45. CONCLUSION & REVIEW:Strategies for Gaining Competitive Advantage, High-performance Work System